Disability Insurance Feature – Return of Premium

I’ve been getting quotes for own occupation disability insurance from various insurance agents and they all promote the “return of premium” feature as being the best thing since sliced bread. Whenever a sales person promotes a product aggressively, my suspicion sensor trips and sets off an alarm. In my experience, heavily promoted financial products are usually a better deal for the sales person than for the consumer. Back to the task at hand, is return of premium worth the extra monthly charge? Lets start off with the basics.

What is Return of Premium (ROP)?

Return of Premium is where you pay an extra fee / month for the “potential” of getting some money back after x amount of years. In my case, I would get 50% of my premiums returned to me in 7 years providing that no claims are made.

An Analysis

Say that instead of purchasing the ROP, we invested the amount instead. Below is a table consisting of the premium payback that I was quoted, the payback after inflation, and the invested payback if we were to put the money into the markets instead.

Assumptions:

2.5% inflation.

2.5% return on the markets after inflation and taxes.

0.25% return on the savings account after inflation and taxes.

The cost of the ROP is $276.07/year or $25.05/month. Lets assume that I’m frugal and I pay the annual “value” price.

Table: Return of Premium vs Investing

Year

Premium Payback

Premium Payback After Inflation

Invested Payback

Savings Account

8

$3,266.80

$2,681.21

$2,747

$2,509

15

$3,266.80

$2,255.61

$2,411

$2,227

22

$3,266.80

$1,897.57

$2,411

$2,227

29

$3,205

$1,566.16

$2,411

$2,227

36

$3,050

$1,253.84

$2,411

$2,227

37

$435.79

$174.78

$559

$553

Total:

$16,491.19

$9,829.17

$12,950.00

$11,970

Conclusions

Judging from the table (and my assumptions), it appears that the return of premium payout does not justify the annual fee.

If (and only if) no claims were made over the 37 years of disability premiums, the ROP would pay a total of $9829.17 after inflation. If we were to invest the annual fee instead, returning 2.5 % after inflation and taxes, we would end up with $12,950, a difference of $3,120.83 in today’s dollars. In fact, if the money was simply put into a savings account returning only 0.25% after inflation and taxes, the savings account would come out ahead by $2,140.83.

To put the final nail in the coffin, a factor not accounted for in the table is the “risk” taken when purchasing the return of premium as it assumes no claims are made. If a claim is made, it would would result in a $0 payback!

My conclusion? Instead of ROP, it should be called RIP (off). Before accepting any “extra features” on insurance products, or any product for that matter, make sure to run the numbers first.

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About the author: FT is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.

Nice analysis. It’s interesting that even with very conservative investment returns, ROP is a very bad idea (for the client). I agree with you that any financial product heavily pushed should be examined carefully.

The apparently small added cost of ROP reminds me of extended warranties on electronics. You’re essentially being asked if you’d like to pay extra. After all, it doesn’t seem like very much more money to get 50% of your premium back later.

25 bucks a month? That’s insane. I used to sell insurance and “riders” never usually cost that much. When I was in the business the big deal was pushing ROP for critical illness policies. The major reason I left insurance was because I felt “dirty” for selling a certain product based on what was best for the company, as opposed to what was best for the client. I had a job offer from an independent financial planner but the foul taste in my mouth led me to leave the financial industry altogether.

I recently signed up for disability insurance through Rene at Insure Your Future (http://www.disabilityinsuranceadvisor.com). We discussed the return of premium and he encouraged me to take the difference in premium and invest it in a CD or somewhere else that would generate interest instead of letting the insurance company hold it. Made sense so I went that way.

That’s a great comparison but you assume people will invest that extra premium money, fat chance. They will cash it out the first time they see that big screen TV they always wanted. Sometimes forced savings work, just not for the financially astute readers of investing blogs like this :)

If you don’t have the discipline to put your money to work, you probably aren’t informed enough to search out disability insurance. You’re most likely waiting for the government to bail you out of the mortgage you can’t afford.

Understand that I am a believer in ROP and allow me to explain why. FrugalTrader’s argument is great (to a point) in theory however it ignores a basic fact of North American culture – WE DO NOT SAVE – WE SPEND. According to an article published in CA Magazine.com, the average RRSP contains $50,000 – that will do NOTHING for us when we need it. “Buy Term and Invest the Difference” MUST BE an older concept than I am (I am almost 63) but it only works IF YOU DO IT. Now – let us take ROP as an option on DI (By the way I have specialized in Living Benefits for just a couple of months short of 40 years) – it should be sold as the LAST option to a client who has already purchased the important riders – regular occupation extension, guaranteed insurability and Partial/Residual. It should be sold to YOUNG clients – particularly males – who believe nothing can happen to them. Even if the client does not buy it, he often agrees to see us because we tell him he collects either way.

Now – let’s look at the 4 possible ranges of scenarios
(1) You NEVER claim – you have only paid half what you put in.
(2) You go on claim and NEVER go off. You really do not care – because premiums are being waived – you are not paying tehm
(3) You have a limited duration – say 4-5 years of claim. Your refund is delayed but you still collect for the premiums you paid and did not collect on
(4) You become a chronic claimer – you request that the option be removed.

Understand – the important thing is you buy this protection, You can no longer rely on Group Plans – please do not even consider Board of Trade or other such plans because the definitions and exclusions significantly reduce coverage.

Oh – and by the way – if an advisor sells ROP, his commission is REDUCED.

Tim, thanks for the great counter argument, much appreciated. Most of the readers of this blog ARE savers and are attempting to get financially ahead. The article simply points out that if you have the discipline to put aside the money, the ROP isn’t the best “feature” to be added onto disability insurance.

I agree – if you are a saver then there is no real value to it – but I still come back to the basic argument that everyone needs – and very few have – this type of protection. Our most important assets are our health and our ability to earn an income. Without the income, discipline does not help you much. The only occupations that are well protected are professionals – and basically only two of them – doctors and dentists. PLEASE – unless you are working solely for the pleasure you get out of it – make sure your income is protected. I learned when my brother survived his car accident – only to get Hepatitis C from the transfusions needed to save his life – how truly valuable this protection is and how limited the protection offered by Group Insurance is in today’s world.

Thanks for the comment by the way – my Lord a place where posts are responded to professionally!

The best “add-ons” are cost of living (increases with inflation) and partial disability. Also, Future Earnings Protector Option Rider
(Provides the opportunity to increase your monthly benefit regardless of changes in your health).

People often forget that the Guaranteed Insurability feature also guarantees your original occupation class – one reason why I STRONGLY suggest that people who have worked for a company from anywhere from 3-5 years buy at least a small personal policy with this feature included – because if they ever get “down-sized” or just decide to change careers they not only keep this protection but can even increase it using a better occupational class than they would almost certainly otherwise obtain. It is not just a “health” thing – it is also a “country of residence” thing as well as an “occupational class” thing. I would rank it as the most important optional feature – even a bit ahead of “Partial”/”Residual”

Am I missing something here. This is an optional rider to “invest” $276.07 for 8 years to get $3,266.80 back. My calculatations tell me this is about an 8.50% annual compound rate of return – after-tax, guaranteed! How much risk would you have to take in a market investment (GIC won’t work) to get the same results? OK, maybe not totally guaranteed if you make claims in excess of 20% of premiums paid but then you have another return called a disability claim. I agree this is a luxury rider for those with the cash flow that is otherwise going to non-registered investments that I would argure have little chance of making 8.50% after-tax, virtually guaranteed in just 8 years.

Glenn, thanks for stopping by. My calculations above assumed that the amount invested would return 2.5% after inflation and taxes. Note that the ROP benefit does not account for inflation which eats away at it’s benefit over the years. After the 22 year mark, even a high interest rate savings account would come out ahead of the ROP benefit.

Hi FT, I don’t understand how you could realistically assume getting a 0.25% after-tax and inflation rate of return from a savings account?? An ING High Interest Savings Account is paying what 3.00%, less 31.15% in marginal taxes for an average $50k/yr Ontarion income earner leaves just 2.07% before inlation which is assumed to be 2.50% and so the net return is -0.43% for the savings option. Compare this to a gross rate of return of about 8.50% for the ROP option less 0% tax because under current tax law this is a tax free insurance pay-out, less 2.50% for inflation and the ROP has a 6.00% rate of return after-tax, after inflation. While dividend and capital gains have preferred tax treatment these investment options come with potentially alot of volatility leaving them poor options to the ROP. I would suggest looking at this situation in 8 year increments and every 8 years ask yourself do you still want the ROP rider or the disability insurance for another 8 years. Below is a chart comparing the various options after-tax, after inflation assuming they could all be reasonably expected to make the same gross rate of return with a high degree of probabillity. (Sorry don’t know how well this will show up).

But “selling” a product is NOT a BAD thing. How many of us walk around without car insurance? (I do but I never learned to drive) or house insurance?Even if our car was destroyed TOTALLY we are looking at a high end loss of what? $150 or $200K if we drive a TOP END car. Our home? Well that is a little more.

46% OF BUSINESS OWNERS HAVE NO DI INSURANCE! How many of us count on our Group LTD? – How many of us can count on our JOB? TODAY?

Our most important assets are our health and our ability to earn an income. If I can get in front of you because of ROP – or because of any other feature – that is a GOOD THING. Whether or not you BUY that feature is not really relevant – at least you will be informed of the risk.